Fairholme and Third Avenue Try Out Bond Funds

If you like  Fairholme Fund (FAIRX), you'll probably like Fairholme Focused Income (FOCIX), too. And if you're a fan of  Third Avenue Value (TAVFX), you'll probably be intrigued by Third Avenue Focused Credit . But don't be fooled by the similarity in the names of these two new funds. They're charting very different courses.

Fairholme and Third Avenue are known for their stock funds, but neither is new to bonds; Third Avenue, in particular, has long specialized in distressed debt. But Fairholme Focused is staking out conservative territory, taking little interest-rate risk and only modest credit risk, while Third Avenue Focused is assuming a whole lot of credit risk. Both aim to achieve their objectives by holding relatively few bonds--15 to 50 in Fairholme's case, and 50 to 60 at Third Avenue.

The funds are drawing a lot of investor interest right away. Third Avenue Focused Credit is up to $434 million and Fairholme Focused Income has quickly grown to $180 million.

Differing Goals
The funds give their managers a lot of flexibility, but they have very different aims. Bruce Berkowitz, who runs Fairholme Fund, sees Focused almost as an enhanced money-market fund that will invest in a mix of cashlike instruments and high-grade corporate bonds. Depending on your perspective, Focused is either a sedate multisector fund or a bold short-term bond fund.

By contrast, the initial portfolio disclosed by Third Avenue Focused is pretty junky. It's filled with corporate bonds and bank loans that have below-investment-grade ratings. High-yield investors expect credit risk, of course, but the new Third Avenue fund may give them more than they bargained for. After all, even the best-managed junk-bond funds usually suffer a few blowups every year.

Differing Approaches
Another difference in the funds is crystal-clear: Expenses for Fairholme Focused will be low for at least a little while. The fund officially charges 1% annually, but it is waiving half that for the first year; it requires a $25,000 minimum investment. Third Avenue is charging a hefty 1.40% a year, although its minimum is just $2,500. If you have $100,000 to spare, you can buy the institutional shares  for 0.95% a year.

A third difference is that Third Avenue has added some brainpower to its fund. Six professionals are dedicated to Focused, led by Jeff Gary, who came from BlackRock (Third Avenue founder Marty Whitman is not on the Focused team). Fairholme, by contrast, hasn't added staff. It will be run by the same people who run Fairholme Fund: Berkowitz and comanager Charles Fernandez. But given Fairholme Fund's fabulous record, you could argue this is a plus.

A fourth difference was apparent in how the funds were launched. Third Avenue Focused Credit quickly built up a portfolio, while Fairholme Focused initially was largely in cash. If you check out its chart, you'll see the fund was flat through February and early March but then jumped to life and passed the benchmark and category averages it had been lagging. Berkowitz had bought CIT debt shortly before it popped. It appears Berkowitz is gradually putting money to work, but don't hold your breath waiting for it to be 100% in bonds.

Puzzling New Releases
The new funds, although intriguing, raise the issue of whether a concentrated approach makes sense for bonds. Concentration can work for stock funds because a stock is capable of doubling or tripling in a relatively short period of time. If that sizzler is one of 20 holdings, it can have an outsize impact on performance. But you rarely get those kinds of pops with bonds. Over the years, most of the best bond-fund managers have held diversified portfolios in which even top holdings typically account for less than 2% of assets.

Then there's the matter of what bond investors seek. Most dislike risk and simply want income and steady returns. I doubt many people will buy into the new Fairholme and Third Avenue products expecting run-of-the-mill bond funds. Those investors will likely favor the unique way Third Avenue and Fairholme pick stocks.

I like the creative approach the two funds are taking to chasing value in the bond market, and I consider them welcome additions to the marketplace. But I would invest in them cautiously. Extend your planned holding period beyond what you would normally allow for funds in their categories--Fairholme Focused may turn out to be riskier than a typical short-term bond fund, and Third Avenue Focused is shaping up to be one of the bolder junk-bond funds.

This article originally appeared in Kiplinger's.

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